A 1930s president set tariffs to put America first, then a world war broke out: is history repeating itself now?

Qian Liu says policymakers have sown the seeds of another economic meltdown because they went for a quick fix to the 2008 global financial crisis
Wealth and income inequality are at historically high levels, and might precede crises as severe as the Great Depression and the second world war

Qian Liu

Published: 12:09am, 12 Nov 2018

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The next economic crisis is closer than you think. But what you should really worry about is what comes after: in the current social, political and technological landscape, a prolonged economic crisis, combined with rising income inequality, could well escalate into a major global military conflict.

The 2008 global financial crisis almost bankrupted governments and caused systemic collapse. Policymakers managed to pull the global economy back from the brink, using massive monetary stimulus, including quantitative easing and near-zero (or even negative) interest rates.

But monetary stimulus is like an adrenaline shot to a stopped heart: it revives the patient, but it does nothing to cure heart disease. Treating a sick economy requires structural reforms, which can cover everything from financial and labour markets to tax systems, fertility patterns and education policies.

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Policymakers have utterly failed to pursue such reforms, despite promising to do so. Instead, they have remained preoccupied with politics. From Italy to Germany, forming and sustaining governments now seems to take more time than actual governing. And Greece, for example, has relied on money from international creditors to keep its head (barely) above water, rather than genuinely reforming its pension system or improving its business environment.

The lack of structural reform has meant that the unprecedented excess liquidity that central banks injected into their economies was not allocated for the most efficient uses. Instead, it raised global asset prices to levels even higher than before 2008.

In the United States, housing prices are now 8 per cent higher than they were at the peak of the property bubble in 2006, according to the real estate website Zillow. The cyclically adjusted price/earnings ratio, which measures whether stock prices are within a reasonable range, is now higher than it was both in 2008 and at the start of the Great Depression in 1929.

As monetary tightening reveals the vulnerabilities in the real economy, the collapse of asset-price bubbles will trigger another economic crisis – one that could be even more severe than the last, because we have built up a tolerance for our strongest macroeconomic medications. A decade of regular adrenaline shots, in the form of ultra-low interest rates and unconventional monetary policies, has severely depleted their power to stabilise and stimulate the economy.

President Herbert Hoover's inaugural ball at The Mayflower Hotel in Washington, D.C., in March 1929. Before the year was over, the Roaring Twenties would come to an end and the Great Depression would begin. Within a decade, the second world war would break out. Photo: Reuters

If history is any guide, the consequences of this mistake could extend far beyond the economy. According to Harvard’s Benjamin Friedman, prolonged periods of economic distress have also been characterised by public antipathy against minority groups or foreign countries – attitudes that might fuel unrest, terrorism, or even war.

For example, during the Great Depression, American president Herbert Hoover signed the 1930 Smoot-Hawley Tariff Act, intended to protect American workers and farmers from foreign competition. In the subsequent four years or so, global trade shrank by two-thirds. Within a decade, the second world war had begun.

To be sure, the second world war, like the first, was caused by a multitude of factors; there is no standard path to war. But there is reason to believe that high levels of inequality can play a significant role in stoking conflict.

According to research by economist Thomas Piketty, a spike in income inequality often precedes a great crisis. Income inequality then declines for a while, before rising again, until a new peak – and a new disaster. While the causality has yet to be proven, given the limited number of data points, the correlation between inequality and chaos should not be taken lightly, especially with wealth and income inequality at historically high levels.

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This is all the more worrying in view of the numerous other factors stoking social unrest and diplomatic tension, including technological disruption, a record-breaking migration crisis, anxiety over globalisation, political polarisation and rising nationalism. All are symptoms of failed policies that could turn out to be trigger points for a future crisis.

Voters have good reason to be frustrated, but the emotionally appealing populists they are supporting are offering ill-advised solutions that will only make matters worse. For example, despite the world’s unprecedented interconnectedness, multilateralism is increasingly being eschewed, as countries – most notably, Donald Trump’s America – pursue unilateral, isolationist policies. Meanwhile, proxy wars are raging in Syria and Yemen.

Against this background, we must take seriously the possibility that the next economic crisis could lead to a large-scale military confrontation. By the logic of political scientist Samuel Huntington, considering such a scenario could help us avoid it because it would force us to take action. In this case, the key will be for policymakers to pursue the structural reforms they have long promised, while moving beyond finger-pointing and antagonism to engage in a sensible, respectful global dialogue. The alternative might well be a global conflagration.

Qian Liu is an economist based in China. Copyright: Project Syndicate

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